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1 s2.0 S0956522107000255 Main PDF
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Management
S C A N D I N AV I A N J O U R N A L O F
Abstract
This paper examines the strategy of multinational enterprises in the global economy with
particular emphasis on their strategies in and about China. It outlines the rise of globally distributed
manufacturing, services and marketing under the control of a focal rm (the global factory) and
applies this analytical framework to strategies in China. The paper outlines the constraints on future
growth in China and the interacting effects of these constraints with the strategies of foreign rms.
r 2007 Elsevier Ltd. All rights reserved.
Keywords: Multinational enterprises; Foreign direct investment; China; Global strategies
1. Introduction
This paper examines the development of strategies of multinational rms against the
background of the globalisation of markets. It is argued that markets are integrated
globally at differential speeds and that this provides opportunities for multinational rms
who are also key drivers in the processes of globalisation. Location and ownership
strategies are analysed in detail together with policies concerning the crucial role of
knowledge creation and management. The concept of the global factory is introduced as
an integrated network (often controlled by a focal rm) that combines core functions,
distributed manufacturing and service operations and marketing networks. The paper then
examines the rise of China as a world economic power. The challenges facing China are
$
This article is based on the authors Viipuri Prize Lecture in Lappeenranta University of Technology,
Finland, 7th September 2006.
Tel.: +44 113 343 4646; fax: +44 133 343 4754.
E-mail address: pjb@lubs.leeds.ac.uk.
0956-5221/$ - see front matter r 2007 Elsevier Ltd. All rights reserved.
doi:10.1016/j.scaman.2007.02.007
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delineated with particular attention to the challenges facing multinational rms in China.
Constraints on Chinese growth are examinedit may seem strange to investigate such
constraints when China is growing at an historically unprecedented rate but severe
restrictions are appearing on its future growth potential. This then leads on to the crucial
needs of the Chinese economy and to the role that multinational rms can play in the
future. The nal section examines strategy in the current Chinese context.
2. The conict of markets with national policies in the global economy
As Sideri (1997, p. 38) says Globalisation is essentially a process driven by economic
forces. Its immediate causes are: the spatial reorganisation of production, international
trade and the integration of nancial markets. It is not therefore uniform across economic
spacethe segmentation of the manufacturing process into multiple partial operations
which combined with the development of cheap transportation and communication
networks, has brought the increasing division of production into separate stages carried
out in different locations. The strategies of multinational rms are therefore crucial to the
causes and consequences of globalisation.
We can examine globalisation as a conict between markets and management (policies).
Fig. 1 identies three levels of marketsnancial markets, markets in goods and services
and labour markets. Each of these is moving at a different speed towards global
integration. Financial markets are already very closely integrated internationally, so that
no individual national capital markets can have a sustainable independent existence.
However, attempts at national regulation do persist (Laulajainen, 2000) and the role of
localities in the nancial markets still provides differentiation (Berg & Guisinger, 2001;
Tickell, 2000). Despite this, it is legitimate for analytical purposes to hypothesise a single
integrated global capital market. Regional economic integration (REI) is becoming
increasingly effective in integration goods and services markets at the regional level.
MARKETS
MANAGEMENT
INTERNATIONAL
CAPITAL MARKET
Conflict of national
policies (locational)
Capital flows
GOODS & SERVICES
MARKETS
REGIONAL
REGIONAL
REGIONAL
Integration,
Harmonization
and protection
regional policies
Labour
Services
LABOUR
MARKETS
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National
employment
Training and fiscal
policies
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The relationship between company strategy and policy making within regional blocs such
as the EU is a fascinating area for the development of new research streams (Chapman,
1999; Raines & Wishlade, 1999; Wood, 2003). Labour markets, however, are functionally
separate at the national level and here integration is largely resisted by national
governments (Buckley, Clegg, Forsans, & Reilly, 2001).
While the largest multinational enterprises are already perfectly placed to exploit these
differences in the international integration of markets (Buckley, 1996), however, REI
offers both large and small rms the opportunity to enjoy the advantages of a large home
market, whether it is their native home or their adoptive home. The operation of
international capital markets (which allow rms to drive their capital costs down to a
minimum) have largely transcended policy on regional integration, although each region
would hope to retain its own regional nancial centre. It is primarily in the arena of the
creation and fostering of regional goods and services markets, that enable rms to exploit
economies of scale across several countries, that REI offers the most substantial size-ofcountry benets. However, regional integration that encompasses countries with
differential labour markets is becoming increasingly benecial. This regional integration
enables costs to be reduced by locating the labour-intensive stages of production in the
cheaper labour economies within the integrated area. Firms that serve just one regional
market, as well as those that serve several of the regional goods and services markets of the
world through horizontally integrated foreign direct investment (FDI), are able to
complement this with vertically integrated FDI in quality-differentiated labour markets.
Vertical integration also reects the spatial distribution of supplies of key inputs and raw
materials. The multinational enterprise achieves advantages through both vertical and
horizontal integration. Each strategy is promoted by the size of country benets of REI in
goods and services markets, which reduce or eliminate articial barriers to trade between
the members. This maximises the ability of rms to exploit intra-regional differences in
factor abundance, including differentiated human capital.
At industry level, globalisation can be shown to have an increasing impact. Gersbach
(2002) denes globalisation at the micro-level as the exposure of a productivity follower
industry in one country to the productivity leader in another country (p. 209). The
transmission mechanisms of change across country borders are trade and FDI. Gersbach
found a strong relationship between globalisation and productivity differences with the
most efcient producers. He concludes that globalisation matters and that its inuence
spreads beyond a single region (e.g. Europe, North America).
More attention has been paid to vertical relationships (the supply chain). The
differentiation of labour markets is most acute between advanced and less-developed
countries which are typically not part of the same regional bloc. The managers of MNEs
are increasingly able to segment their activities and to seek the optimal location for
increasingly specialised slivers of activity. This ability to separate and relocate stages of
production has led to a boom in manufacturing in China and service activities (e.g. call
centres) in India. MNEs are also increasingly able to co-ordinate these activities by means
of a wide variety of mechanisms from wholly owned FDI through licensing and
subcontracting to market relationships. The more precise use of location and ownership
strategies by MNEs is the very essence of increasing globalistion.
In parallel with the growth of the globalisation of production, globalisation of
consumption has accelerated and it is perhaps this which has excited most opposition. The
alleged globalisation of tastes provokes nationalistic protectionist sentiments and is here
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analysed in terms of the balance of strategies within MNEs between local and global
pressures on the rm.
The process of globalisation is thus not only reorganising power at world level but also
at national and subnational levels (Alden, 1999; Dunning & Wallace, 1999; Graham, 2003;
Peck & Durnin, 1999; Pike, 1999; Yeung, 2003). As domestic rms move part of their
production to other countries, technology, knowledge and capital become more important
than land, the traditional source of state power, and this redenes the function of the state
(Rosecrance, 1996; Sideri, 1997). The loss of sovereignty to supra-national regional
institutions is more acceptable than to international institutions which are more remote.
The EU is an example of such regional integration and governance (Bressand, 1990).
Social programmes within the EU are enforcing major re-distributions of revenue between
the individual nations. The nation state as the possessor of the sense of identity is being
replaced by subnations and internal regions as government is devolved.
Subramanian and Lawrence (1999) found that national locations remained distinctive.
Policy barriers at the borders, differences in local cultures in their widest sense and nature
and geography contribute to distinctiveness. This, together with the ability of incumbents
to keep outsiders at a disadvantage (Buckley et al., 2001) and the rst entrant benets of
local rms, reinforce the differentiation of national economies. International competition
remains imperfect and international price differences persist because arbitrage is costly.
Domestic market conditions largely determine prices and wages. Multinational rm
afliates remain rmly embedded in their local economy and such local rms identify
closely with the national government. Subramanian and Lawrence (1999) conclude that
national borders still matter. Borders continue to engender and to coincide with important
discontinuities stemming from government policies, geography and societal differences.
The authors stress information discontinuities which coincide with national boundaries
and so create search and deliberation problems for trading and manufacturing rms. These
issues also account for the alleged home bias of multinational rms. FDI is the key tool
by which multinationals bridge cross-border discontinuities.
The two contrasting paradigms of a world made up of self-contained national economies
and a borderless world are incomplete and capture only part of a complex and subtle
story. Lenway and Murtha (1994) examine the role of the state as strategist along four
dimensions: authority vs. markets, communitarianism vs. individualism, political vs.
economic objectives and equity vs. efciency. They state that international business
scholarship places a benchmark value on efcient international markets and tends to
regard states as causes of deviation from this ideal (p. 530).
3. Location and ownership strategies of multinational rms
The traditional MNE was a vertically, as well as horizontally, integrated rm. In
consequence, each division of the rm was locked into linkages with other divisions of the
same rm. As global competition intensied, there was growing recognition of the costs of
integration of this kind. Commitment to a particular source of supply or demand of any
product, intermediate good or service is relatively low-cost in a high-growth scenario, since
it is unlikely that any investment will need to be reversed. It is much more costly in a lowgrowth scenario, where production may need to be switched to a cheaper source of supply,
or sales diverted away from a depressed market. The desire for exibility therefore
discourages vertical integrationwhether it is backward integration into production, or
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GLOBAL
LOCAL
Cost
Revenue
Efficiency
Responsiveness
Centralisation
Decentralisation
Standardisation
113
Adaptation
GLOCAL?
The globalisation of markets has been a major factor in the growth of volatility (Buckley
& Casson, 1998). A feature of many global markets is the use of regional production and
distribution hubs, where several neighbouring countries are serviced from the same
location. The regional hub, like the IJV, can be understood as a strategy that offers
superior exibility. Just as an IJV offers a compromise ownership strategy, a regional hug
offers a compromise location strategy. Because the hub is nearer to each market that is the
home location, it reduces transport costs, and offers better information capture too. Yet,
because it is close to several markets, it avoids exclusive commitment to any one. If one
market declines, production can be switched to other markets instead provided the shocks
affecting the national markets are independent (or less than perfectly correlated, at any
rate) the hub provides gains from diversication. These are real gains that only the rm can
achieve, as opposed to the nancial gains from unrelated product diversication, which
have proved disappointing in the past because they are best exploited through the
diversication of individual share portfolios instead.
3.3. Location and ownership strategies revisited: hub and spoke strategies
The two strategies of IJV and hub can be combined. (Fig. 2). Since one (the IJV) is an
ownership strategy and the other a location strategy they can, if desired, be combined
directly in an IJV production hub. Closer examination of the issues suggests that this is not
normally the best approach, however. The model suggests that a combination of a wholly
owned production hub supplying IJV distribution facilities in each national market is a
better solution. A hub facility is too critical to global strategy to allow a partner to become
involved, because the damage they could do is far too great. Even with a wholly owned hub
facility, the combination still affords considerable exibility to divest or withdraw from
any single market. The advantage of the combination is that when divesting, the
distribution facility can be sold to the partner, while the production capacity can be
diverted to markets elsewhere. These options for divestment are combined with useful
options for expansion too. This example illustrates the crucial role that the concepts of
exibility and volatility play in analysing foreign market entry in the modern global
economy. Without these concepts it is impossible to fully understand the rationale for IJVs
and production hubs. It is also impossible to understand why these strategies have emerged
at this particular historical juncture and not before Fig. 3.
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Warehousing
and
Adaptation
IJV
Distribution
IJV
Wholly Owned
Production and
Warehousing
Hub
Warehousing
Distribution
and
Adaptation
IJV
Warehousing
Distribution
and
Adaptation
IJV
Fig. 3. Hub and spoke strategies: an example.
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Parts
Supplier
Parts
Supplier
Parts
Supplier
Contract
Assembler
Outsourced Parts
Supplier
Design
Engineering
Branding
Marketing
BRAND OWNER
Contract
Assembler
Design
Contractor
Engineering
Contractor
R&D
Contractor
Core Functions
Parts
Supplier
Warehousing,
Distribution
and
Adaptation
Parts
Supplier
Distributed Manufacturing
To this end, policies are implemented that enable rapid economic growth without
destabilising the political control of the Communist Party. This combination is difcult to
sustain, particularly in issues concerning the freedom vs. control of informationthe rst
is necessary for economic development, the second for one-party control. These are not the
only challenges facing China. Chinas economic challenges are many and varied:
the shock of normal economic restructuring across all sectors, following rapidly
intensifying competition, especially from overseas
competing on a global level playing eld with a highly concentrated global business system
the IT revolution and modern production systems on employment
the drastic impact of the global media revolution upon Chinese culture
for its peoples self-esteem, should it fail to establish a collection of powerful indigenous
corporations
dealing with the dominating presence of foreign-owned corporations
societal disparities (urban vs. rural, western vs. coastal)
institutional reform at all levels of government and administration
When these challenges are translated into business and economic conditions, they pose
difculties for foreign enterprises as we shall see. Among the most serious are:
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Partnership issuesnature and outlook of partner (JVs vs. wholly owned subsidiaries).
Business culture and difculties of corruption and misperception.
Protecting intellectual property and intangible assets.
Technology transfer to China.
Personnel and workforce issuesalready a skills shortage in certain areas and regions
of China.
Uncertain and insecure property rights.
Making and remitting prots
Despite its outstanding recent annual growth rates (and it is difcult to believe the exact
gures), China faces some severe constraints on its future growth. These are: political
constraints, the availability of the unnecessary inputs, bilateral and multilateral diplomacy,
labour issues, rigidities and bottlenecks in the domestic economy, the environmental
impact of growth and innovation related issues.
In terms of political constraints on economic growth, the primary issue is the political
and social contradictions between Communist central control and the ssiparous forces
behind a free trade environment. There are intense rivalries between Provinces, regions and
cities which have distorting effects. The process of economic growth in China has led to
major inequalitiesthe most obvious ones being between rural and urban areas, the
interior and the rapidly developing coastal areas and between different classes of workers
and the elite. Although the central government has managed the transition to a modern
economy skilfully, this has meant restrictions on freedom such as freedom of movement
within China and, most seriously, on freedom of information. There is also rising
dissatisfaction with corruption. Externally the Taiwan issue remains an unresolved area of
tension. Finally, these strains are only alleviated by the rapid rate of growth. Rising
expectations are currently being fullled, but were the growth rate to falter, it would be
more difcult for the Government to cope with its potential political difculties.
Second, the rapid growth of China requires a huge input of resources. The rising cost of
energy and raw materials is a major consequence of Chinas growth. This has led China to
seek relationships with key providers globally and is a major motivation for Chinese
outward direct investment (Buckley et al., forthcoming). China is thus led into
relationships with some unsavoury regimes such as Sudan in order to secure long-term
access to key resources. The costs of inputs are thus rising politically as well as
economically.
Third, Chinese bilateral and multilateral diplomacy needs to be of a very high order to
sustain its access not only to inputs but also to nal markets. Its competitors (ASEAN and
India for instance) are concerned at the loss of their markets domestically and globally and
at Chinas huge share of inward direct investment. Its customers are concerned at Chinas
market share of their markets. The fruits of Chinas success are currently ploughed into US
nancial assets leading to concern about future liquidation. All these issues threaten future
instability if not carefully managedand the management of some of these issues is
outside Chinas control.
Fourth, China faces severe problems with labour. The availability of a cheap, hard
working labour force remains a key competitive advantage for China. However, there are
strong signs that in certain areas, skilled labour shortages are beginning to emerge. Table 1
shows that for certain key types of workers, Chinese costs are overtaking those in India by
a considerable amount. Training requirements in China are huge and will be increasingly
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Table 1
China/India wage comparisons2005 wages in multinational rms
Project managers
Financial analysts
Production worker
Customer care
China ($)
India($)
23,409
13,194
2334
2418
10,039
8408
1853
1601
NB: average pay rises in multinationals in past 5 years: China 7.5%, India 11.5%.
Living costs in Chinese coastal cities greater than in India.
Chinese pay is higher for 95% of 42 job categories considered in the study but the pay differential is less stark at
lower levels.
Wage costs, of course, are only one factor in the investment decision.
Source: Mercer Human Resources Consultancy as reported in Financial Times 15.11.05, p. 10.
costly as Chinese industry upgrades. There are also indications that Chinese workers are
becoming more demanding and they are ceasing to accept inequalities. Issues of health and
safety are also beginning to emerge. Chinese labour costs will, inexorably, rise.
There are severe rigidities and bottlenecks in the Chinese economy which slow growth and
will increasingly do so unless solutions are implemented. The Chinese banking system is
inefcient and outmoded. Indeed, the overall inefciency in the capital market is severe and is
one reason why FDI is so vital to Chinas development. Banks are one aspect of unreformed
state owned enterprises (SOEs) that are such a burden to the economy. The infrastructure of
China, particularly transport, requires huge investment to cope with the expansion of the
economy and creates bottlenecks in supply and distribution. Internal migration is strictly
managed and the question must be asked as to how long this can co-exist with increasing
liberalisation of markets. Finally, we should not forget that China has a huge (and largely
unreformed) agricultural sector in which, still, a majority of workers is employed.
The deleterious environmental effects of Chinas rapid growth cannot be escaped.
Pollution is already at dangerous levels in most centres of population. Regulation is as yet
weak and unsystematic largely as a result of fears that environmental improvements will
show growth. This issue represents possibly the major challenge for Chinese policy makers
and multinational forms.
Finally, China faces an innovation challenge. So far its growth has been based on
subcontracting from foreign rms and imitative domestic growth. In future, China needs to
be creative, to develop and nurture R&D and to secure the development of domestic brand
names. This requires a different approach from Government level down to individual rms
and entrepreneurs. It also requires a rm and fair system of intellectual property protection.
Nurturing creativity poses a major challenge to the current political system, requiring more
openness, freedom of information, more liberal education and a shift in values.
5. Application of strategies to China
5.1. Location and ownership strategies
The response of MNEs is differential across national markets. Even in the globalised
economy, national markets are not equal. China is a market that matters to the
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multinationals. It is also endowed with large quantities of workers whose real wage
productivity is high (this efciency wage is effective because of low wage rates when
expressed in hard currency). Further, it has large supplies of basic resources. China can
therefore attract FDI which is market orientated, cost orientated and input orientated.
This might be deemed to be sufcient explanation of its massive share in hosting world
FDI. However, imperfections in the domestic market are responsible for a considerable
proportion of this inow, as we shall see. A reduction of these imperfections would reduce
Chinas share of world FDI but increase its output efciency.
The choice of FDI over other forms of foreign market servicing strategy is the rst stage
of an entry strategy. After FDI has been chosen, the rm faces other key decisions. It has
to choose between a wholly owned subsidiary (not allowed in China before 1986) or a JV
and between a takeover or a greeneld venture. Below, we examine these choices in general
and then apply the analysis to the special case of China.
All markets are to some extent unique, or at least idiosyncratic. Special factors in China
include the nature of JVs, especially forced JVs which impact on the strategies of entrant
rms, supply chain problems and the reform process. (Buckley, Clegg, & Tan, 2003).
5.2. Ownership entry strategies
Entry strategy in China has three clear forms of ownershipwholly owned subsidiaries,
freely chosen JVs and forced JVs, where JVs are a second best strategy from the point of
view of the entrant MNE, but where legislation or local pressure makes JVs the only viable
choice. This tripartite distinction applies particularly to FDI aimed at the domestic market.
Many MNEs are trying to unravel their Chinese JVsUnilever, Alcatel and Michelin have
already done so. This is reminiscent of the double-entry method of market servicing which
the author observed in Japan some time ago (Buckley, Mirza, & Sparkes, 1995) where a
later WOS replaces an earlier JV in the same market (often, after competing with it). This is
not smooth dynamic entry! It should also be pointed out that not all JVs are unsuccessful.
Honda is reported to make its most protable Accord model in China. VW has half of the
Chinese market for passenger cars (although this is aided by local favouritismShanghai
makes sure that the citys taxis are Santanas!). (Economist 13.4.02, p. 71).
5.3. Dynamic market entry
Investment attraction (and retention) requires attention to be paid to dynamic market
entry. Investment agencies need to take a long-term view of the foreign market servicing
strategies and sourcing strategies of multinational rms. This includes both locally owned
rms and foreign investors. There is a worrying trend of declining protability of MNEs in
ChinaBeamish and Jiang (2002) report this decline for Japanese MNEsand although
larger MNEs take a long run view of their investments, ultimately this problem will deter
inward FDI. In China, the dynamic market entry model outlined above faces challenges in
implementation. There are high switching costs between strategies in China. Ownership
strategy has not been a free choice until recently in many industries. JVs with local entities
were de facto or de jure the only means of entry. Once established, it is difcult for an
MNE to extricate itself from its partners clutches. In addition, it is generally difcult to
effect entry via takeover. M&As are difcult in China except where the current owner
(usually a state body) wishes to ofoad a quantity of unwanted assets onto the incomer.
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Switching costs are high and entry choices are limited. Moreover, exibility is limited by
the stickiness of the Chinese environment and of government policy. Imperfections limit
the range of choices and often prevent the type of exibility in entry and development
outlined above. Although now legal in some areas, mergers and acquisitions are still
difcult and costly to carry out in China.
5.4. Integrating China into a global strategy
Agencies concerned with inward FDI should understand the hub and spoke strategy
and monitor its development. Attraction of hubs with higher order activities (R&D,
nance) is particularly attractive, but spokes may well develop into hubs or subhubs. This
may involve supporting or fostering international JVs between local rms with the ability
to develop complementary skills and foreign rms. Investment may not always be
greeneld ventures on a new site but mixed forms with JVs and takeovers as key entry
strategies. A more sophisticated attitude to takeovers is implied by this approach. As a
large country physically and in population, MNEs will eventually develop such a strategy
within China.
From the domestic policy point of view, location decisions create a two-dimensional
problem. First, there is concern to attract MNEs into China. Second, there is excessive
competition between cities and regions in China. The second aspect can reduce, or
eliminate, the benets of the rst. Competition between the Pearl River Delta, the Yangtze
River Delta and cities such as Shenzen and Shanghai can be counter-productive. National
regulations can be subverted by regional or local deals (e.g. Shenzen has also moved
ahead of Chinas WTO commitments in areas such as logistics, allowing companies such as
US retailer Wal-Mart to set up a wholly owned global procurement centre in its
jurisdiction Financial Times 11.12.02, p. 6 Reforms dull prospects for Pearl Rivers
worker army).
There is much more competition for footloose FDI projects. The entry of China as a
major location for labour-intensive projects has created major difculties for those
countries trying to compete as a location for export-orientated projects. Many countries
are engaged in attempting to upgrade their offer to potential inward investors. This may
include direct cost competition or attempts to attract higher order activities and skilled
labour/knowledge-intensive projects. The switch of footloose FDI to China from
competing locations may have permanent repercussions.
In competing for high tech inward investment China still has areas of disadvantage. In
comparing China with India as a location for software development UBS Warburg (2002)
found that language barriers, the lack of relationships in the US and Europe and the lack
of scale and fragmented units in the Chinese industry were serious disadvantages. Chinas
period of isolation from the global economy has meant that repatriation of skilled
engineers and managers has not occurred (unlike India). Past piracy of software and
lingering worries about the made in China label continue. Management difculties are
still prevalent. The UBS Warburg (2002) report comments on the apparent inability of
top managers to engage in multiple projects simultaneously (p. 13). This contrasts with
other studies of Chinese managers and management style which are usually praised for
their ability to hold contrasting views simultaneously.
There are, however, real signs of success. Motorolas China Software Centre was set up
in 1993 and the company currently has three such centres in China. Taken together, this is
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the second largest R&D software centre for Motorola outside the USA (after India). The
Centre carries out a series of high-tech co-operation projects with local software
companies. Here is evidence of an MNE led high tech hub.
Despite the above pessimism, subcontracting into China in IT and growth in demand for
basic manufactures (e.g. automobiles) continues to drive growth in China (IT puts re in
the belly of dragon economy and Auto industry could soon be driving Chinese
expansion Times 12.12.2002, p. 30). Domestic policy on infrastructure (roads, motorways) continues to support the massive growth in middle-class demand (GM overtaken
by Chinas love affair with the car Financial Times 2.12.02, p. 25) such as Chinese
(underscale) plants cannot cope with the demand.
The entry of China as a global economic superpower and super-location for inward FDI
may be consolidated by its membership of the WTO and its policy of increasing openness.
Chinas range of exporting industries covers the spectrum from cheap labour intensive
products like toys to sophisticated ones like computer chips. China may have areas of
absolute advantage, but trade is based on comparative advantage. Further, as Chinas
trade balance becomes increasingly positive, its exchange rate will rise. The growth of
Chinas domestic purchasing power will also provide opportunities for importers to tap
this new consumer base.
The era of massive new greeneld projects designed for export may be passing. Much
more likely are incremental changes in MNE congurationthe results of de-duplication,
outsourcing, offshore production and re-investment. The volatility of strategy increasingly
makes FDI a two-way bet unless strong investment retention policies are in place. The
rationalisation of facilities by MNEs is ongoing and relentless.
Chinas accession to the World Trade Organisation is likely to have major effects for
MNEs operating there. First, internal reforms are likely to accelerate. Second, the service
sector will become more open, liberalised and efcient. Third, China will become more
integrated into the global economy. (Huang, 2001). All three of these effects will create
opportunities for domestic rms If they are allowed to take these opportunities, privately
owned rms will be able to remove some of the imperfections to which MNEs react in
China. Private rms are currently constrained by lack of capital and ofcial disapproval
(Huang, 2003). The removal of articial capital market constraints on local rms will allow
them to compete more effectively with foreign owned ones, who benet disproportionately
from their ability to exploit (and in some cases, reduce) imperfections in Chinese domestic
markets.
There are several key imperfections in the Chinese domestic sector which interact with
the strategies of multinationals. One important area is the existence of SOEs across
wide swathes of the Chinese economy causing overcapacity in (for example) chemical
fertilisers, steel construction materials and coal. SOEs exhibit a lack of understanding and
a lack of resources for modernising and marketising. Although, in some cases, the
enterprises themselves may be willing to restructure, the Central Government will not
allow this to happen for fear of rendering their workforces useless. Further, local
governments often lobby for and protect their SOEs against those in other cities (e.g.
ofcials in Wuhan have given tax breaks to anyone who buys a car made in the local car
plant (Economist 13,4.02, p. 71). SOEs are generally overdiversied (unspecialised) and
difcult to evaluate in performance terms because their accounting procedures are so
awful. The elimination of this inefciency by M&A is hampered by political interference,
protectionism and lack of transparency. MNEs are therefore, rightly, cautious when
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considering acquiring privatised SOEsand perhaps they should be more cautious when
involving SOEs in JVs.
Chinas development is very much manufacturing sector driven, following the pattern
set by Japan and then the newly industrialising economies of Southeast Asia. At current
exchange rates, China is the fourth largest producer of manufactured goods in the world
(BNP Paribas Pereguine, 2002). The service sector, including (critically) banking, lags in
development and for legislative and logistical reasons, remains much less open to FDI than
manufacturing.
The key message of this paper is that volatility in the global economy is increasing. IJVs
for instance are likely in general to be short-lived but variable in longevity. There will not
be massive successes in attraction of new greeneld investments or massive failures in
closure, but the search for exibility will mean that incremental shifts will be many and
cumulatively profound. Switching costs for MNEs in achieving exible strategies are
increasing in importance.
5.5. Impact on the strategy of MNEs
Domestic distortions in China interact with the strategy of MNEs in the following ways:
1. Ownership strategy becomes crucial. Initial entry determines the availability of strategic
choices in the life of the Chinese investment for MNEs.
2. Flexibility in altering ownership choice in China is limited because the switching costs
are high. It is often difcult to move out of a JV as option strategy would suggest and an
inefcient second entry may be required.
3. Location choices within China may be determined by political, not commercial and
economic, factors.
4. Problems of outsourcing may in the short run at least provoke excessive internalisation
of activities where the choices of establishing a purchasing network and/or importing
are ruled out by quality and regulatory problems. Similar forced overextension of
activities may occur in distribution, too.
The result of these distortions is that the rst best operational structure of MNEs is
impossible in China. The Economist alleges that not a single car plant in China benets
from economies of scale (13.4.02, p. 72). Many in-house operations are suboptimal and too
costly because of excessive internalisation due to the lack of efcient external markets. JVs
are often forced rather than free choices. The lure of the Chinese market and low-cost
operation outweigh these factors in many rms global strategies but they will not
necessarily always do so in the face of competition from other locations. Many rms would
prefer to outsource and subcontract production to Chinese rms and to keep their xed
assets elsewhere. It is only domestic distortions which prevent a new equilibrium with more
local Chinese ownership, less FDI, and more non-ownership modes of MNE operation
from prevailing.
This suggests that China should focus on creating local rms which can act as factories
for hire, allowing MNEs to subcontract production to them and ensure quality outputs.
The analysis here suggests that, for labour intensive export goods, MNEs increasingly face
the choice of FDI in China or subcontracting production to super subcontractors
elsewhere. The balance may shift away from China as exibility increases in importance.2
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6. Conclusion
John Dunnings OLI (Ownership, Location and Internalisation) framework can be
used to organise the conclusions of this analysis.
6.1. Location factors
Globalisation and improved management techniques including the use of e-commerce,
have meant that MNEs are much more capable of accessing the best locations for each of
their constituent activities. The increased exibility analysed in this paper means that
locations are more competitive with each other both between and within nations. This may
also imply unhealthy race to the bottom in which locations desperate for inward FDI
compete in removing environmental, social, scal and labour legislation in an attempt to
win a bigger share of footloose global FDI. In China, there is a major regional disparity
between coastal locations and the interior. In time, policy makers may take a dualistic
view of inward FDI policy, following a Singapore strategy of upgrading the quality of
FDI in the coastal regions, whilst following a relatively undifferentiated attract FDI at all
costsparticularly labour-intensive FDI to the interior. Several MNEs may be induced
by this strategy to relocate labour-intensive activities to the interior, whilst upgrading their
coastal activities. For such an upgrading strategy to proceed, the quality of inputs and
infrastructure will have to be improved, and imperfections removed.
There is also a major challenge for China in moving FDI beyond the labour-intensive
stage. As the analysis above showed, for export orientated products speed to market and
other non-price factors, such as design, are becoming more important in many sectors than
cost. Improved infrastructure, transport and communication in particular are becoming
key competitive advantages even in industries hitherto reliant on unskilled labour to
achieve price competitiveness.
The size and growth of the Chinese market will remain important in attracting FDI
aimed at local market servicing.
6.2. Ownership
Ownership is a critical variable in both entry and operation in China (Buckley et al.,
2003). Restrictions on the preferred ownership strategy of MNEs will deter inward FDI
and will introduce distortions. China has relaxed the policy of forced JVs and allowed
the operation of wholly owned subsidiaries in an increasingly large area of industry and
commerce. Services remain largely restricted however and forced IJVs, particularly with
inefcient (state owned) entities remain problematic.
The source of MNEs remains a major factor in determining their impact on the Chinese
economy. Investors from the Chinese diaspora are very different in type, structure and
impact from those from the West.
Inward FDI is still inuenced by policy-induced distortions, such as round tripping.
Where agents in one province move investment out of the country in order to re-invest it in
another Chinese province and/or to receive the benets accorded to foreign direct
investors.
In the medium to long run, outward FDI by Chinese multinationals and the
encouragement of domestic entrepreneurship are key factors. Linkages, learning effects
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and stimulation of domestically owned rms are important measures of both the impact of
inward FDI and its generation of outward investment on the lines of the investment
development cycle (Buckley & Castro, 1998; Dunning, 1981a, b, 1986; Dunning & Narula,
1996).
6.3. Internalisation
The changing boundaries of the rm are both a cause and a consequence of globalisation
and e-commerce and a reection of changing managerial imperatives in MNEs. The
potential for vertical disintegration allows MNEs to seek out not only the best locations
for each activity but the best internalisation/externalisation choices. As distortions are
removed in the Chinese economy MNEs are likely to switch to contractual modes of doing
business such as subcontracting or licensing, rather than relying on internalised modes of
operation such as FDI. The elimination of excessive internalisation will (paradoxically)
reduce inward FDI but increase operational effectiveness in China as MNEs outsource
activities which they have been compelled to internalise by imperfections in external
markets (Buckley & Casson, 1976).
6.4. Summary
At the moment, there are severe distortions in each of the above OLI factors. Location is
distorted by (often competing) regional incentives and political inuences. Ownership is
distorted by forced JVs. Internalisation is distorted by the excessive internalisation used
in response to created imperfections in markets. The pattern of FDI would be very
different (and will be in the future) as these distortions diminish.
China still needs an industrial policy. Removal of the key distortions is often a job for
government and a free-for-all policy is unwarranted and probably dangerous (see the
analogue for East and Central Europe (Buckley & Ghauri, 1994; Casson, 1994). The
structure of incentives created by current policy favours MNEs rather than domestic rms.
Despite the distortions, China has been outstandingly successful since the beginning of the
open-door policy. It still has a long way to go in releasing its potential economic power and
inward FDI is both a signal of this success and a sign that current policies have in-built
biases, which in the medium term are costly for China, inefcient and ultimately growth
inhibiting for the domestically owned sector.
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